Do Business Schools Incubate Criminals?

By Luigi Zingales -
Jul 16, 2012

The recent scandals at Barclays Plc,
JPMorgan Chase & Co., Goldman Sachs Group Inc. and other banks
might give the impression that the financial sector has some
serious morality problems. Unfortunately, it’s worse than that:
We are dealing with a drop in ethical standards throughout the
business world, and our graduate schools are partly to blame.

Consider, for example, the revelations about two top
executives at the elite consulting firm McKinsey & Co., which
has avoided public vilification despite the transgressions of
its former employees. McKinsey director Anil Kumar, -- a
graduate of the University of Pennsylvania’s Wharton School --
pleaded guilty to providing insider information to hedge-fund
manager and fellow Wharton alumnus Raj Rajaratnam. Rajat Gupta,
a graduate of Harvard Business School who served for nine years
as McKinsey’s worldwide managing director, was convicted of
insider trading in the same case.

Although Gupta had long left McKinsey when the actions
leading to his conviction took place, it would be shortsighted
not to take the problem seriously. While every firm can have its
bad apples, when these bad apples are at the top, it suggests
that a company has either a corrupt culture or a defective
selection process, or both. This is particularly troubling at a
company like McKinsey, which cites the integrity and quality of
its consultants as key advantages. “Keep our client information
confidential” is one of its credos, proudly displayed on its
website.

Where did Gupta, Kumar and others get the idea that this
kind of behavior might be OK? Most business schools do offer
ethics classes. Yet these classes are generally divided into two
categories. Some simply illustrate ethical dilemmas without
taking a position on how people are expected to act. It is as if
students were presented with the pros and cons of racial
segregation, leaving them to decide which side they wanted to
take.

Others hide behind the concept of corporate social
responsibility, suggesting that social obligations rest on
firms, not on individuals. I say “hide” because a firm is
nothing but an organized group of individuals. So before we talk
about corporate social responsibility, we need to talk about
individual social responsibility. If we do not recognize the
latter, we cannot talk about the former.

Economics and Greed

Oddly, most economists see their subject as divorced from
morality. They liken themselves to physicists, who teach how
atoms do behave, not how they should behave. But physicists do
not teach to atoms, and atoms do not have free will. If they
did, physicists would and should be concerned about how the
atoms being instructed could change their behavior and affect
the universe. Experimental evidence suggests that the teaching
of economics does have an effect on students’ behavior: It makes
them more selfish and less concerned about the common good. This
is not intentional. Most teachers are not aware of what they are
doing.

My colleague Gary Beckerpioneered the economic study of
crime. Employing a basic utilitarian approach, he compared the
benefits of a crime with the expected cost of punishment (that
is, the cost of punishment times the probability of receiving
that punishment). While very insightful, Becker’s model, which
had no intention of telling people how they should behave, had
some unintended consequences. A former student of Becker’s told
me that he found many of his classmates to be remarkably amoral,
a fact he took as a sign that they interpreted Becker’s
descriptive model of crime as prescriptive. They perceived any
failure to commit a high-benefit crime with a low expected cost
as a failure to act rationally, almost a proof of stupidity. The
student’s experience is consistent with the experimental
findings I mentioned above.

In other words, if teachers pretend to be agnostic, they
subtly encourage amoral behavior without taking any
responsibility. True, economists are not moral philosophers, and
we have no particular competence to determine what is ethical
and what is not. We are, though, able to identify behavior that
makes people better off. When a theater catches fire, the
individual incentive is to rush to the exit as fast as possible.
Yet if everyone in the audience rushed at once, the crowd near
the door would allow fewer people to escape -- indeed, many
could die. Not surprisingly, there are social norms against this
behavior. People who violate those norms are judged rude,
egotistical, ill-behaved, or in certain cases even criminally
negligent.

When the economist Milton Friedman famously said the one
and only responsibility of business is to increase its profits,
he added “so long as it stays within the rules of the game,
which is to say, engages in open and free competition without
deception or fraud.” That’s a very big caveat, and one that is
not stressed nearly enough in our business schools.

Free Competition

Lobbying to secure a competitive advantage from the
government certainly does not represent “open and free
competition.” Similarly, preying on customers’ addictions or
cognitive limitations constitutes deception, if not outright
fraud. Not to mention using clients’ confidential information
for personal gain, manipulating a major interest-rate benchmark
such as Libor, or selling financial products you know to be
flawed.

The way to teach these ethics is not to set up a separate
class in which a typically low-ranking professor preaches to
students who would rather be somewhere else. This approach,
common at business schools, serves only to perpetuate the idea
that ethics are only for those students who aren’t smart enough
to avoid getting caught.

Rather, ethics should become an integral part of the so-
called core classes -- such as accounting, corporate finance,
macroeconomics and microeconomics -- that tend to be taught by
the most respected professors. These teachers should make their
students aware of the reputational (and often legal) costs of
violating ethical norms in real business settings, as well as
the broader social downsides of acting solely in one’s
individual best interest.

Of course, no amount of instruction can prevent some people
from engaging in bad behavior. It can, however, contribute to a
social consensus that would discourage diffuse fraud, like the
widespread misreporting of Libor rates or the willful self-
delusion and dishonest dealing that helped turn the subprime
crisis into a global financial disaster. The daily scandals that
expose corruption and deception in business are not merely the
doing of isolated crooks. They are the result of an amoral
culture that we -- business-school professors -- helped foster.
The solution should start in our classrooms.

(Luigi Zingales is a professor at the University of Chicago
Booth School of Business and the author of “A Capitalism for the
People: Recapturing the Lost Genius of American Prosperity.” The
opinions expressed are his own.)